Cryptocurrencies - Asset Class or Legal Tender?

The basic mistake that central banks and governments are making is to equate cryptocurrency with legal tender. Cryptocurrencies – despite their name – are not currencies.

By Prosenjit Datta

The Union Budget introduced the cryptocurrency tax. The Finance Minister announced that 30% tax would be applied on income from the transfer of digital assets – which presumably means cryptocurrencies, non-fungible tokens (NFTs), and any other such digital token-based products). If they were given as gifts, they would be taxed in the hands of the recipients. And no set-off against losses would be allowed.

Later in the evening, senior Finance Ministry bureaucrats clarified that this did not bestow legitimacy to cryptos. India is one of the few countries which empower the taxman to collect dues from both legal and illegal activities. The government will decide later on whether cryptocurrencies should be made legal. Its current uncertain legal status does not prevent it from being taxed.

The government’s hesitancy in bestowing legal status to cryptos probably stems from the staunch opposition of the central bank. The Reserve Bank of India (RBI) wanted crypto assets banned. It had issued a circular to that effect in 2018 but the Supreme Court ruled against the ban.

Central Banks globally see cryptos as a threat to their authority of issuing and managing the legal tender in their countries. A peer-to-peer global exchange system that bypasses their regulatory authority is obviously not something they can support. Some central banks are trying to bring out their own alternatives. China already has an official digital currency and in her speech, the Finance Minister announced that India too planned to have one.

However, the basic mistake that central banks and governments are making is to equate cryptocurrency with legal tender. Cryptocurrencies – despite their name – are not currencies. They do not have any underlying value – being untethered to any physical asset and not guaranteed by anyone official. They only follow the basic rule of supply and demand, with the mining process determining the supply.

Only Bitcoin, the original cryptocurrency has been conferred with the status of a legal tender by one country, El Salvador. It doesn’t have its own currency. It used the US dollar as its legal tender and now is also accorded the same status as Bitcoin. It is currently facing a fairly rough ride because of the volatility in the crypto market.

Many economists think that cryptos are a bubble and they could well be. With no physical asset underpinning them, their value derives from the supply, demand, and what buyers are willing to pay. But they are here to stay for the foreseeable future.

Many countries treat cryptos as an asset class, not legal tender. If the Indian government is taxing crypto income, it makes ample sense to do the same. And build a regulatory mechanism for them – on the lines of the SEBI perhaps but only focused on digital assets and with properly licensed and regulated trading platforms. The approach will allow only the most established cryptos and other digital assets to be traded, on the basis of clear and transparent rules, and keep track of them. This will bring some law to what is essentially a wild west at the moment.

Prosenjit Datta was the Editor of Business Today and is currently with Ernst & Young as Advisor Analytics and Content

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